Special Edition: Putting Market Corrections Into Perspective Weekly Update – October 20, 2014

Image courtesy of FreeDigitalPhotos.net/renjith krishnan

Image courtesy of
FreeDigitalPhotos.net/renjith krishnan

Markets posted another week of losses amid continued fears, though markets trimmed losses on Friday on better-than-expected earnings results from top companies. For the week, S&P 500 lost 1.02%, the Dow fell 0.99%, and the Nasdaq dropped 0.42%.1

After reaching new highs in mid-September 2014, markets have been roiled by volatility and selling pressure. We know that market declines can be nerve wracking and we wanted to take the opportunity to discuss the recent pullback with our clients.

Market Corrections are Normal

Since 1928, the S&P 500 has generally experienced between three and four corrections of more than 5.00% each year; the October pullback was the 20th decline of 5.00% or more in the current bull market.2 Declines of 10.00% or more are rarer, but are still seen nearly every 1½ years.3 Obviously, these are all averages and the performance of any single year can deviate significantly from historical norms.

In the current bull market cycle, markets have experienced just two declines of 10.00% or more: in Spring 2010 when the Federal Reserve launched its quantitative easing programs and in Summer 2011 when the euro appeared to be in trouble.4

Putting the Current Selloff Into Perspective

After a lengthy period of market gains – between January 1, 2013 and September 19, 2014, the S&P 500 gained 43.35%5 – many analysts were confident that a selloff had to happen eventually. The current selloff has largely been spurred by a combination of global worries: recessionary fears in Europe, slowing growth in China, some disappointing domestic economic reports, and Ebola concerns all contributed to the drop.

How far equities decline during a selloff depends on a lot of factors, including investor sentiment, corporate earnings, economic data, and growth prospects for the near future. In this case, markets are largely moving because of fear, not because of fundamental factors, so we can hope that the selloff will be brief. Although we ended the week with a loss, equities halted their slide on Friday and regained ground on the strength of recent earnings reports.6 Is the decline over? Hard to say.

Though the past can’t predict the future, we can look back at past market declines for hints of what we might expect going forward. Since 2009, pullbacks of 5.00% or more have lasted an average of about a month, peak to trough, meaning that the recent downturn may not be completely over.7

As of Friday’s close, the S&P 500 was down 6.19% since its peak in mid-September.8 Markets have gone 1109 trading days since the last 10.00% + correction. Since the average is around 509 days between corrections, we might be overdue. However, we went more than 2,500 trading days between corrections in the mid-nineties, so there is precedent for the winning streak to continue.9 Let’s also keep in mind that although the S&P 500 has lost ground this year and is hovering around 2.00% return, it’s still up more than 8.00% since the same period last year.10

Looking Ahead

The week ahead is thin on economic data but earnings season will be in full swing, which means that positive earnings could override fear-based selling. However, global worries still exist and it’s unknown how long the present weakness in the market will continue. We can hope that lower equity valuations, decent corporate earnings, and seller exhaustion will help push investor sentiment into positive territory as traders “buy the dip.”

Though some economic headwinds exist, we believe that slowing growth in Europe will have only a modest impact on the U.S. economy. Declines in oil prices may be a net positive for the economy as consumers have more money to spend; weakness in the euro should help European exports and mitigate recessionary fears. Corporate earnings appear to be reasonably decent, which should also help spur market growth. While we can’t predict the future, we believe that economic fundamentals are solid and favor continued market growth.

Conclusions

Though market corrections are rarely welcome, they are a natural part of the overall business cycle and it’s important to take them in stride. Declines also provide an environment to test your risk tolerance and ensure that your financial strategies and asset allocations are aligned with your long-term objectives and appetite for risk.

As professional investors, we’ve learned to seek out the opportunities in market corrections and volatility. Declines often create openings for tactical investing and allow us to invest in high quality companies at attractive prices. While we can’t use the past to predict the future, history tells us that having the patience to sit out brief rough patches often benefits our clients in the long run.

We hope that you have found this information educational and reassuring. If you have any questions about market corrections or are concerned about how the recent pullback may have affected your portfolio, please give us a call; we’re always happy to speak with you.

ECONOMIC CALENDAR:

 

Tuesday: Existing Home Sales

Wednesday: Consumer Price Index, EIA Petroleum Status Report

Thursday: Jobless Claims, PMI Manufacturing Index Flash

Friday: New Home Sales

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HEADLINES:

Jobless claims plummet to 14-year low. Applications for new unemployment benefits unexpectedly fell to the lowest level since April 2000 as employers trimmed fewer jobs. Although this may be a blip, it’s a positive sign that businesses are boosting payrolls in the face of global uncertainty.11

Oil prices bounce back from four-year low. Brent crude oil prices moved above $86/barrel as investors speculated on oversold market conditions. Oil prices have largely moved on expectations of shifts in supply and demand rather than actually observed conditions, which may cause prices to move upward again, though changing fundamentals may keep oil prices low.12

Mortgage rates fall, spark refi mini-boom. Mortgage rates dropped below 4% last week, falling to their lowest level since June 2013. The drop has spurred a boom in refinancing as homeowners scramble to take advantage of lower rates.13

Mixed retail sales data leaves analysts guessing. Slow retail sales numbers and weak earnings reports from big retailers contrast with the optimistic forecasts of industry analysts, who are predicting strong holiday sales growth. It’s a situation where macroeconomic data supports strength while the microeconomic numbers from individual firms paint a weaker picture.14

Goal-based Investors Know Where to Focus Weekly Update – October 13, 2014

Image courtesy of FreeDigitalPhotos.net/ddpavumba

Image courtesy of
FreeDigitalPhotos.net/ddpavumba

Concerns about global growth caused markets to hit the brakes last week in a cloud of smoke and volatility, giving the S&P 500 and Nasdaq their worst week since May 2012. For the week, the S&P 500 lost 3.14%, the Dow slid 2.74%, and the Nasdaq dropped 4.45%.1

Macro-economic issues dogged markets last week and investors fell prey to concerns about issues like slowing growth in Europe, Ebola, the situation in Ukraine, and the coming end to the Federal Reserve’s quantitative easing programs. A confluence of fears helped open up a trapdoor beneath stock markets, but much of the selloff can be attributed to concerns about how a strong dollar and a weak European economy could hurt company profits. Both of these factors may combine to erode demand for U.S. exports and hurt businesses that rely on overseas demand.2

On the other hand, a weaker euro might be just the ticket Europe needs to stoke demand for its exports and jumpstart economic growth, much as a soft dollar helped pull the U.S. out of recession. A weak euro makes European products more competitively priced, hopefully boosting demand and giving the Eurozone economy a push.

As investor sentiment swung towards a fear-based selloff, investors ignored positive domestic economic news in favor of pessimistic headlines and questioned the soundness behind the recent run-up in stock prices. It’s not uncommon for periods of strong market gains to be interrupted by short-term pullbacks, but as long as the underlying economic trends in the U.S. remain solid, we can hope for more upside this year.

Bottom line: Threats to the market exist in the form of a slowdown in global growth and wildcards like the Ebola epidemic and security issues overseas. However, overall, the U.S. economy is doing well and many sectors are experiencing broad-based growth that’s driven by solid economic fundamentals. Though markets slid last week, let’s take a look at how far we’ve come since last year: As of last Friday, the S&P 500 has gained 12.62% since October 14, 2013.3  While these pullbacks are often frustrating, keep in mind that as goal-based investors, we are more focused on how long-term performance affects our personal financial goals and less focused on short-term market behavior.

With a thin economic calendar next week, analysts will be shifting their attention to Q3 earnings as U.S. banks and some technology companies begin to report.  Historically, as earnings season ramps up, analysts tend to focus less on macro-economic issues in favor of company-level data. Thus far, earnings expectations are modest, with S&P 500 companies expected to show 1.6% earnings growth on 1.7% higher revenues.4 However, keep in mind that many companies purposefully keep the bar set low so that they can benefit from positive earnings surprises. While more volatility is likely, positive earnings results could shift sentiment and encourage investors to buy the dip and give stocks a boost.

ECONOMIC CALENDAR:

 

Wednesday: PPI-FD, Retail Sales, Empire State Mfg. Survey, Business Inventories, Beige Book

Thursday: Jobless Claims, Industrial Production, Philadelphia Fed Survey, Housing Market Index, EIA Petroleum Status Report, Treasury International Capital

Friday: Housing Starts, Consumer Sentiment

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Jobless claims fall to lowest level since before recession.
Weekly claims for new unemployment benefits fell sharply last week, pointing to continued improvement in the labor market. Initial claims dropped to 287,000, beating out estimates of 294,000 new claims.5HEADLINES:

Federal Open Market Committee Minutes show concern for growth. The minutes from the Fed’s September FOMC meeting showed little change from previous reports, indicating that quantitative easing will likely end on schedule this month. However, economists are worried about the effect of slow overseas growth on U.S. exports.6

Job openings surged in August. The latest reports show that the number of open jobs increased more than expected in August, led by industries like manufacturing, social assistance, and healthcare. This is good news for future hopes about the labor market.7

Oil prices tumble below $84. Crude oil prices fell below $84/barrel Friday for the first time since 2012 on concerns about global demand. Surging U.S. output also lessened worries about supply, pushing gasoline prices to an average of $3.24 across the U.S.8

October 2014 Monthly Market Update

Gains and Growth: Contributions to a Strong Q3 Weekly Update – October 6, 2014 3rd Quarter Edition

Image courtesy of FreeDigitalPhotos.net/emptyglass

Image courtesy of
FreeDigitalPhotos.net/emptyglass

After some market stumbles in recent weeks that erased earlier gains, stocks ended about where they started at the beginning of the quarter. However, broad economic gains means that solid fundamentals could contribute to market upside later this year. For the quarter, the S&P 500 gained 0.62%, the Dow grew 1.29%, and the Nasdaq added 1.93%.1

What are some of the factors that contributed to strong market performance in Q3?

After a very slow start to the year, economic growth rebounded in the second quarter, giving investors confidence that the economic recovery was still healthy. The latest estimate of Q2 gross domestic product (GDP) growth showed that the economy grew 4.6%;2 while official Q3 numbers aren’t out yet, some estimates indicate that the economy may have slowed slightly in the past three months, but could still clock in a healthy 3.0% gain.3

The labor market made great strides last quarter, adding 671,000 new jobs in the past three months. In September, hiring accelerated and the jobless rate reached a six-year low of 5.9%.4 To compare: In September of 2013, the unemployment rate stood at 7.2%, and the labor market added just 430,000 jobs.5 On the other hand, wage growth seems to be frozen, indicating that many Americans are failing to see income gains that could lead to greater consumer spending.6

Strong corporate profits coming off of the second quarter helped boost markets by showing that demand is improving across many sectors. Even better, Q3 guidance was modestly higher, indicating that corporate leaders felt more positive about their chances going into the second half of the year.7 We’ll know whether their optimism was merited once Q3 earnings reports are released.

What could act as headwinds in the weeks and months to come?

Geopolitical issues continue to drag on market performance as the situation in Ukraine continues to simmer and parts of the Middle East roil with violence. Since these areas play key roles in global petroleum and natural gas production, supply disruptions could have a serious impact on fuel prices.

Europe and Japan continue to struggle with stubbornly weak economic growth and low inflation, prompting calls for additional central bank activity. If these major U.S. trading partners continue to experience trouble, it could weaken market outlooks this year.

The Federal Reserve was a big player last quarter, and its monetary policy decisions will likely impact market activities in the coming weeks and months. The current round of bond purchases are scheduled to end in October, bringing the Fed’s quantitative easing programs to a halt.8 Investors are now turning their attention to the question of when the Fed will begin raising interest rates, and speculations will likely lead to further market volatility.

Markets have been running high, with multiple indexes reaching new records in the third quarter, which can sometimes presage a pullback as investors pause to take stock of the market environment. Is a pullback certain? Definitely not. Bottom line: Domestic economic fundamentals are strong going into the final three months of the year. As earnings start trickling in, solid performances could translate into further market upside. As always, we recommend staying focused on long-term goals instead of short-term volatility and market performance.

ECONOMIC CALENDAR:

 

Tuesday: JOLTS

Wednesday: EIA Petroleum Status Report, FOMC Minutes

Thursday: Jobless Claims

Friday: Import and Export Prices, Treasury Budget

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HEADLINES:

U.S. auto sales rise. After a sharp increase in August, sales of cars and light trucks rose on big Labor Day discounts in September. While the higher trend is good news for the industry, price cuts and incentives will chip away at company profits.9

Trade gap shrinks on low oil prices. The gap between imports and exports dropped in August as lower oil prices caused the overall cost of imports to fall. This is good news for consumer spending as lower import costs puts dollars in consumers’ wallets.10

Factory orders drop in August. As expected, orders for manufactured goods plummeted 10% in August, erasing July gains. The July jump was driven by a one-off surge in aircrafts; stripping out the volatile transportation category, core orders were down slightly by 0.1%.11

Consumer confidence drops sharply in September. After hitting a seven-year high in August, confidence among American consumers hit a speed bump as they worried about jobs and income growth. However, consumers were still upbeat about the future, hopefully indicating that consumer spending won’t take a hit in the months to come.12

Do Your Children Understand Money?

Are the young people in your life financially literate? By helping them learn about money, you give them an important head start on important life skills like developing good savings behavior, living within their means, and avoiding many common financial pitfalls.

Unfortunately, many young Americans are not learning the right financial lessons. Research shows that 46% of teens don’t know how to create a budget and 55% would like to know more about managing money. We can’t rely on schools to teach financial skills because many of the practical classes we took no longer exist. Too many kids reach adulthood without knowing how to budget or make important financial decisions.

Based on our experience working with young people, here are some recommendations for helping kids develop the right financial behaviors:

Start early. If your kids are old enough to ask for things, they are old enough to start learning about money. Teach young kids that we have to save for the things we want by helping them choose a toy and then saving to buy it. Use an allowance to teach budgeting skills and incentivize chores with older children. Give kids an age-appropriate allowance – Mint.com has a great piece on average allowances by age. Some parents choose to tie an allowance to specific chores, while others prefer to treat chores as an expected family contribution that is separate from an allowance.

Set financial expectations and be honest about money. Until kids start earning a living and being responsible for their own expenses, it’s easy for them to believe that money grows on trees. Involve kids in everyday shopping decisions so that they understand your thought process behind common financial decisions and learn your values about money. Depending on their age level and maturity, you can also ask for their input when making financial choices. Give them a budget for back-to-school shopping and help them prioritize their spending so that they learn about living within their means.

Expect kids to contribute to their financial future. If your kids have an allowance or receive money on birthdays or holidays, require them to set aside a certain amount for the future.

We recommend using the three-bucket approach: one third of every dollar goes to long-term savings, one third goes to charity, and one third is pocket money. Long-term savings can be used toward education expenses or to pay for a major purchase like a car. By teaching your kids how to allocate money, you help them establish critical saving while teaching them about your values.

Teach kids about debt. It’s very easy for young adults to get in over their heads with credit card debt or student loans. Teach your kids how debt works so that they can evaluate offers and avoid predatory lending. If possible, help your kids establish their credit through a secured credit card or low-limit card that they must pay off each month so that they learn how to manage debt responsibly.

If you’d like help teaching your children, grandchildren, or other young people about money, please reach out to us. As financial professionals, we know the difference financial education can make in someone’s life, and we want to offer ourselves as a resource to you and your family. Together, we can sit down and come up with strategies to make sure the next generation is fully prepared to navigate their finances and make smart decisions about money. We can help you:

  • Establish smart savings behaviors in young children
  • Create college savings strategies
  • Prepare teens for young adulthood
  • Develop strategies for boomerang kids

If we can be of service to your loved ones, please contact us. We’re always happy to listen and help.

Why Do These Fed Decisions Matter? Weekly Update – September 29, 2014

Image courtesy of FreeDigitalPhotos.net/cuteimage

Image courtesy of
FreeDigitalPhotos.net/cuteimage

Markets lost ground last week, though a Friday rally on positive economic data helped trim losses. For the week, the S&P 500 lost 1.37%, the Dow dropped 0.96%, and the Nasdaq fell 1.48%.1

Last week, a lot of market focus was on the Fed. Following the Federal Open Market Committee on September 16th -17th, multiple Fed officials gave speeches outlining their opinions about how the Fed should handle raising interest rates and returning to normal monetary operations. Unsurprisingly, there are some definite differences of opinion amongst the Fed’s top experts.

The hawks: Monetary hawks generally prefer high interest rates because they fear the effects of high inflation more than they worry about weak economic growth. Prominent members of this camp, like Dallas Fed President Richard Fisher, believe that the Fed should start raising rates as early as Spring 2015.2

The doves: Doves tend to favor lower interest rates in order to boost economic growth; they believe that the negative effects of inflation are negligible in comparison with the benefit of increased economic activity. Prominent doves include Chicago Fed President Charles Evans, who favor keeping rates low until they can be certain the economy has enough momentum behind it. Folks in this camp seem to favor keeping rates low for much longer, possibly until 2016.3

Keep in mind that such disagreements are healthy, because there is a lot of room for interpretation of economic data and debate about the effects of economic policy. However, these splits mean that Fed chairwoman Janet Yellen must craft a careful compromise at the October FOMC meeting or risk making financial markets nervous.

Why do these Fed decisions matter? The Fed has held interest rates at rock bottom levels in order to encourage lending and stoke economic activity. Now that the economy is improving, the Fed is starting to think about inflation – which they like to keep below 2% (headline inflation). By slowly raising rates, the Fed plans to avoid the specter of high or unexpected inflation, which can negatively affect the economy by chipping away at buying power. If the Fed raises rates too soon, the economic recovery could falter. If rates are left low too long, inflation could spike.

For bond investors, rising interest rates will affect the market prices of the bonds in their portfolios. As interest rates rise, bond prices fall as new bonds paying higher rates come on to the market. As financial professionals, we spend a lot of time managing these issues for our clients so that they are prepared for rising rates.

Bottom line: We know higher interest rates are coming, we just don’t know when. The good news is that the economy is doing reasonably well and the signs point to continued growth this year.

The minor decline last week wasn’t unexpected. Markets have been trading at record highs and concerns about slowing growth in China and other threats to the global economy caused investors to hit pause ahead of the end of the quarter. Will the decline continue or will investors buy the dip? Hard to say. Looking ahead at the last week of the quarter, a lot of attention will be on the release of the September jobs report, which will hopefully underscore the labor markets improvements. However, a positive jobs report could be the evidence the Fed needs to move away from monetary stimulus, which could cause some market volatility. We’ll know more once we start to see a trickle of Q3 earnings reports and quarterly economic data.

 

ECONOMIC CALENDAR:

Monday: Personal Income and Outlays, Pending Home Sales Index, Dallas Fed Mfg. Survey

Tuesday: S&P Case-Shiller HPI, Chicago PMI, Consumer Confidence

Wednesday: Motor Vehicle Sales, ADP Employment Report, PMI Manufacturing Index,

ISM Mfg. Index, Construction Spending, EIA Petroleum Status Report

Thursday: Jobless Claims, Factory Orders

Friday: Employment Situation, International Trade, PMI Services Index, ISM Non-Mfg. Index

HEADLINES:

Q2 GDP estimate rises to 4.6%. The third estimate of second quarter economic growth was revised upward again, largely driven by greater business and personal consumption. These are excellent indicators for greater growth this year.4

Durable goods orders fall. After July’s surprise surge in aircraft orders, August orders for long-lasting manufactured goods fell. However, excluding the volatile transportation category, so-called core orders rebounded 0.7%, which is a healthy amount.5

Consumer sentiment measure reaches 14-month high. An index of consumer confidence reached the highest level seen since July 2013, also the second highest level in seven years. Americans feel more upbeat about economic growth and rising incomes, which could give consumer spending a needed boost.6

August new home sales swell. August sales of new single-family homes surged to their highest level in six years, supporting hopes that the housing market isn’t done growing yet. However, low supply levels will likely continue to stunt sales activity.7

Coming Up! Earnings, Elections, & the End of the Year. Weekly Update – September 22, 2014

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Image courtesy of jscreationzs at FreeDigitalPhotos.net

Markets regained steam last week, pushed higher by a reassuring Federal Reserve meeting and a referendum on Scottish independence. For the week, the S&P 500 gained 1.25%, the Dow grew 1.72%, reaching a new record, and the Nasdaq rose 0.27%.1

 

As was generally expected, the Federal Reserve voted to continue to taper its quantitative easing programs by another $10 billion per month.2 Digging a little deeper, meeting notes suggest that though the Fed believes the economy is still growing at a moderate pace, economists are still concerned about meager labor participation and growing income inequality. The official statement of the Fed’s meeting shed little light on the timeline for interest rate changes, but Dallas Fed President Richard Fisher stated that the Fed should start raising rates in spring 2015, not summer, as many analysts have predicted.3 It’s too soon to know how markets will react to a sooner-than-expected interest rate increase, especially since economic conditions between now and then may change.

 

The U.S. dollar has been on a tear over the last couple of months, making this the longest winning streak since 1973, and the return of a strong dollar has its share of winners and losers.4 A rising dollar helps fight inflation by making each dollar buy more in goods and services; it also makes it cheaper for Americans to buy imported goods. Since consumer spending makes up about 70% of economic activity, when consumers pocket extra money, it’s generally a win for the economy. On the other hand, a stronger dollar is hard on exporters of U.S. goods, and multinationals who depend on foreign demand are being hit with a one-two punch of stagnant demand from major trading partners in Europe and Asia plus a rising dollar, which further cuts into their sales.

 

So, is a rising dollar ultimately good for the U.S. economy? In the short run, it’ll probably be a net positive, since consumers are benefiting and will be able to spend more money. The long-term effects won’t be known for some time; but, generally speaking, as long as currency movements remain stable, financial markets should be able to adapt.5

 

The week ahead is packed with speeches by Fed insiders, which analysts will be mining for additional details after the Fed’s official statement last week. With the end of the quarter upon us, investors are also starting to turn their attention to earnings, mid-term elections, and positioning their portfolios for the end of the year. Could we still see a correction? Absolutely. While the equity environment is looking healthy and the economy is doing well, a deteriorating economic situation in Europe and China or geopolitical issues in Ukraine or the Middle East could definitely throw a wrench into the works.

 

 

ECONOMIC CALENDAR:

 

Monday: Existing Home Sales

Tuesday: PMI Manufacturing Index Flash

Wednesday: New Home Sales, EIA Petroleum Status Report

Thursday: Durable Goods Orders, Jobless Claims

Friday: GDP, Consumer Sentiment

 

Data as of 9/19/2014 1-Week Since 1/1/14 1-Year 5-Year 10-Year
Standard & Poor’s 500 1.25% 8.77% 16.72% 17.64% 7.81%
DOW 1.72% 4.24% 10.51% 15.19% 6.80%
NASDAQ 0.27% 9.65% 20.86% 22.95% 13.98%
U.S. Corporate Bond Index 0.17% 2.50% 3.51% 1.98% 0.83%
International 0.02% -0.76% 3.07% 3.88% 3.77%
Data as 9/19/2014 1 mo. 6 mo. 1 yr. 5 yr. 10 yr.
Treasury Yields (CMT) 0.01% 0.04% 0.11% 1.83% 2.59%

Notes: All index returns exclude reinvested dividends, and the 5-year and 10-year returns are annualized. Sources: Yahoo! Finance and Treasury.gov. International performance is represented by the MSCI EAFE Index. Corporate bond performance is represented by the DJCBP. Past performance is no guarantee of future results. Indices are unmanaged and cannot be invested into directly.

HEADLINES:

Factory activity falls in September. A key Federal Reserve indicator of manufacturing in the key mid-Atlantic region decelerated this month. The survey, covering factories in Delaware, eastern Pennsylvania, and southern New Jersey, is often seen as a bellwether for national trends.6

Jobless claims fall to lowest level since July. Weekly claims for new unemployment benefits unexpectedly fell to 280,000, putting the labor market back on trend for sustained improvement.7

Scotland votes “no” on independence. The E.U. weathered one of its first serious independence crises when a referendum on Scottish independence was defeated. While the vote was close and the issue may arise again, Scotland (and its valuable North Sea oilfields) will remain part of the U.K. and EU for now.8

Housing starts to drop dramatically. Groundbreaking activity on new homes dropped 14.4% in August, led by a slump in multifamily apartments and condos. As Americans have shied away from homeownership in favor of renting, builders have started work on more rental units, a more volatile category of housing growth.9

Markets Slide Before Key Fed Meeting Weekly Update – September 15, 2014

Image courtesy of FreeDigitalPhotos.net/Stuart Miles

Image courtesy of FreeDigitalPhotos.net/Stuart Miles

Markets closed last week on a down note – breaking five straight weeks of gains – as investors hedged their bets ahead of a pivotal Federal Reserve Open Market Committee Meeting. For the week, the S&P 500 lost 1.10%, the Dow dropped 0.87%, and the Nasdaq slid 0.33%.1

After weeks of great performance, markets finally hit pause as investors declined to push markets higher ahead of a big week. Fed decisions have driven a lot of market activity in recent months and the upcoming FOMC meeting is highly anticipated. Analysts are poised to leap on any hint of Fed economists’ thinking about the state of the economy and the return to normalized monetary policy.

What will the Fed be looking for? Overall, clues that the U.S. economy is still on the path to sustainable, broad-based growth. So much of what the FOMC does comes down to interpretation and reading the tea leaves; Fed economists are accustomed to delving deeply into the data and making judgments based on cloudy and uncertain data.

One of the biggest variables in the Fed’s evaluation of the economy is the labor market. So far, most indicators show that the labor economy is improving, albeit modestly.

The August jobs report was grim and showed that job creation slowed over the last three months. Worse, the labor force participation rate was a measly 62.8%, the lowest rate seen since the 1970s.2

However, fresh research by a group of Fed economists suggests that declines in labor force participation since the financial crisis – often attributed to discouraged Americans who drop their job searches – may actually be due to the natural aging of the U.S. workforce as boomers move into retirement.3 If true, this means that the Fed may be able to discard some of their concerns about discouraged workers.

Digging a little deeper, the number of job openings in the U.S. ticked down slightly in July, but is still close to a 13-year high. On the other hand, the pace of hiring hasn’t kept up with job openings, indicating that workers may be struggling to retool for new jobs or that employers may not be offering competitive wages.4 Unfortunately, these are not problems that the Fed can solve, but economists need to factor these issues into their thinking to ensure that they don’t take away the training wheels too soon.

There are a couple of decisions that could come out of the FOMC meeting. (1) The Fed could decide to continue steadily trimming back bond purchases as they have at every meeting since the taper began in December. This decision would keep us on track for an October finish. (2) If the economic oracles show that the economy is doing well, the Fed could decide to accelerate the pace of its taper, ending its quantitative easing programs ahead of schedule. While doing so would be a huge vote of confidence for the economy, markets might react badly to the news that the party is ending early. (3) If economic prospects look uncertain, the Fed could decide to pause its taper, keeping bond purchases going until the end of the year.

Whatever decision comes out of the meeting, investors can expect some volatility as markets adjust to the news. Investors will also want to gauge the expected effects of a fresh round of sanctions against Russia, which many analysts worry will dampen growth in Europe.5 All told, it’ll be an informative week and we’ll keep you posted.

 

ECONOMIC CALENDAR:

Monday: Empire State Mfg. Survey, Industrial Production

Tuesday: PPI-FD, Treasury International Capital

Wednesday: Consumer Price Index, Housing Market Index, EIA Petroleum Status Report, FOMC Meeting Announcement, FOMC Forecasts, Chair Press Conference 2:30 PM ET

Thursday: Housing Starts, Jobless Claims, Philadelphia Fed Survey

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HEADLINES:

Factory output in China drops. Chinese factory production growth fell to the lowest level in six years, stoking fears that the world’s second-largest economy might be cooling off. Weak readings in several other sectors increase the probability that China’s central bank may undertake additional stimulus.6

U.S. retail sales rise in August. Retail sales, which account for about one third of consumer spending, rose broadly last month. While retail sales levels are still below pre-recession numbers, this increase bodes well for future spending and economic growth.7

Consumer sentiment hits 14-month high. Friday’s report showed that U.S. consumer sentiment rose to the highest level in more than a year, as Americans felt more upbeat about economic conditions. Though Americans still worry about a labor slowdown, they are more optimistic about the future.8

Import prices decline. The cost of imports into the U.S. fell by the largest amount in nine months, largely due to a sudden decrease in petroleum prices. While this drop may be short-lived, lower import prices will help keep inflation down and cut Americans a break on imported products.9

Why Another Uptick in Spite of Bad News? Weekly Update – September 8, 2014

Image courtesy of FreeDigitalPhotos.net/Stuart Miles

Image courtesy of
FreeDigitalPhotos.net/Stuart Miles

Markets chalked up another win last week, pushing the S&P 500 to another record close. After several days of cautious trading, Friday’s August jobs report finally gave investors the push they needed to extend gains for a fifth week. For the week, the S&P 500 grew 0.22%, the Dow gained 0.23%, and the Nasdaq added 0.06%.1

Investors reacted with surprising relief to a disappointing August employment report that showed jobs growth braked to an eight month low. The data shows that payrolls increased by just 142,000, after expanding by over 200,000 in July. Data from June and July was also revised downward, tempering optimism about the labor market recovery. However, even though growth slowed, underlying trends show that slack in the labor market is still slowly being taken up.2 Another positive bit of news is that what jobs were created came from areas like business services, health care, and construction – areas where job seekers can potentially find high-paying, career-oriented jobs.3

Why the positive reaction to disappointing news? This is a case of bad news being treated like good news; investors have been chewing their nails in recent weeks over the possibility that the Federal Reserve could end quantitative easing and hike interest rates sooner than expected. A poor labor market showing takes away some of that risk, giving relieved investors some stimulus to rally.

In Europe, the European Central Bank (ECB) cut interest rates to the bone and announced a new plan to boost lending, neatly avoiding the discussion of whether to engage in a full-scale Fed-style quantitative easing program. If “QE-light” fails, the ECB may be forced to take on the debt of struggling states like Portugal and Spain to boost economic growth. Right now, the bank is counting on constituent governments to do their part by cutting taxes and engaging in economic reform.4 Will this be enough to boost Europe’s stagnant economy in the face of waning demand and economic sanctions against Russia? We won’t really know until next year.

The crisis in Ukraine continued last week, with Russians achieving control over the eastern half of the country, and Western leaders debating whether or not to take a more active military role in constraining Russian ambitions. While U.S. leaders are willing to show their displeasure through further sanctions, the European bloc, sensitive to their dependence on Russian energy, are more reluctant to act.5

The week ahead is slow on economic data until Friday, when analysts will get a look at retails sales, consumer sentiment, and business inventories, all important indicators of economic health. With investor sentiment so high, it’s quite possible that a bump in the road may cause stocks to temporarily turn downward in coming weeks as investors hit pause and take stock of their surroundings.

 

ECONOMIC CALENDAR:

 

Tuesday: JOLTS

Wednesday: EIA Petroleum Status Report

Thursday: Jobless Claims, Treasury Budget

Friday: Retail Sales, Import and Export Prices, Consumer Sentiment, Business Inventories

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HEADLINES:

Factory orders post record gains. Orders for goods from U.S. factories jumped 10.5% in July, driven by strong demand for aircraft and automobiles. Excluding the volatile transportation category, orders for manufactured goods are still on a modest upward trend.6

Fed Beige Book shows pickup in economic growth. The Federal Reserve’s anecdotal snapshot showed that the U.S. economy expanded at a moderate pace over the last six weeks, though its tone was more tempered than other government reports. Overall, the Fed believes economic growth is expanding at a moderate pace.7

Motor vehicle sales grew 6% in August. A strong Labor Day showing helped sales of light vehicles to grow significantly year-over-year, indicating that American consumers are feeling confident enough about their prospects to make big-ticket purchases. Overall, sales are expected to increase in coming months due to pent-up demand and improving employment conditions.8

Chain stores reported solid August sales growth, indicating that the back-to-school shopping season was solid. Though chain stores make up only 10% of retail sales, they are an important indicator of overall consumer spending trends.9

September 2014 Monthly Market Update